Bold Stroke May Be Beyond Europe’s Means

Europe may need a broad cure to its debt crisis, but the increasingly awkward pairing of the European Union and the International Monetary Fund makes such action unlikely.

Just three days after a 110 billion euro ($134 billion) bailout of Greece was presented as the latest step to stabilize European markets, the opposite has transpired. Fears have spread through the financial markets that a larger epidemic would infect Spain, Portugal and perhaps other indebted countries outside the euro zone, like Britain and the United States.

In response, analysts are calling for a shock and awe option — some rescue of the largest of the peripheral euro zone economies suffering from stagnation and high levels of debt, not unlike the Troubled Asset Relief Program that was created to restore confidence in the American financial system.

They suggest that the European Central Bank buy back billions of euros of unwanted Greek, Portuguese and Spanish debt and that the I.M.F. offer a large bailout for Spain.

Such a broad stroke would surely cost more than the $700 billion that the United States pledged to back up its failing banks in late 2008. Therein lies the rub: not only is it an enormous sum, but it requires a degree of flexibility, political courage and teamwork that the European Union and the I.M.F. have not yet begun to show.

“It is not really about money,” said Timothy Congdon, an economist and professed euro skeptic who foresees an exodus of savings from banks on Europe’s periphery to Germany as doubts build about these countries’ staying power in the Eurozone. “It is about how much pain the people in periphery can stand in order to keep this thing going. Once the confidence is gone, and Greeks and Spaniards move their deposits to Frankfurt, it becomes a self-fulfilling prophecy, and the whole thing implodes.”

Officials throughout Europe continue to say that the plan for Greece is sufficient and there is no need for a broader aid proposal or a formal debt restructuring in any afflicted countries. Investors, though, continue to push down the euro, which fell to $1.28 on Wednesday, a significant sign of eroding confidence.

The traditional way to combat unemployment in a recession is to expand the money supply. Such a step puts downward pressure on interest rates and makes capital more plentiful for businesses and consumers alike, spurring economic growth.

Mr. Congdon said recent figures indicate that even after deflationary pressures in Spain and Ireland, and the broader effect of the Greek crisis on credit-starved banks in Europe, there had been no growth in the European Central Bank’s money supply.

This is proof enough, he contends, that the central bank remains under the influence of Germany, which firmly opposes this type of debt monetization, one that has been aggressively deployed in the United States and Britain to combat the recession.

As for the I.M.F., its ambitious managing director, Dominique Strauss-Kahn, has been eager to present the fund as a potential savior for Europe. This is in spite of a postwar track record of providing a specific treatment of fiscal austerity and currency devaluation only when asked. So far, the fund has not shown the type of flexible, multination solution investors now say is warranted.

And even if the fund were called upon to address Europe’s broader debt crisis, doubts remain as to whether it has sufficient funds to do the job properly.

Representative Mark Steven Kirk, Republican of Illinois, a member of the House Appropriations Committee, which oversees financing to the I.M.F., estimates that a bailout of Spain could cost as much as $600 billion. Citing research from the Congressional Research Service, he says the fund has only $268 billion to lend.

With a 17 percent share of the international fund, the United States is the largest shareholder and financial contributor. Given the frustrations after the rescue of its financial institutions, and their subsequent landmark profits, there would seem to be scant appetite in the United States for increasing its support.

But there may be a deeper problem. The classic methodology that the fund uses in such situations — harsh austerity leavened with a currency devaluation — may not be fully applied in this instance. Greece alone does not control the euro, nor does Portugal or Spain.

According to Desmond Lachman, an economist and a former staff member in the fund’s policy review department, it is this dilemma that makes the fund’s job in Europe nearly impossible — especially in light of the 2 trillion euros of outstanding debt in the troubled peripheral economies.

Mr. Lachman argues that currency devaluations are a crucial balancing component to every harsh austerity program because they can kick-start exports and growth, thus diluting the pain of public spending cuts.

But with Greece and other Eurozone economies having a fixed currency, this option is unavailable, forcing the fund to compensate with even deeper austerity measures that prolong recessions and spark the type of social anger that came to characterize the fund’s controversial programs in Southeast Asia in the late 1990s.

For Greece to meet the fund’s target of a budget deficit of 4 percent to 6 percent of economic output in 2014, the government will need to find savings of 13.5 percent of its total output, according to an analysis by Barclays Capital. Such a turnaround has little precedent in past restructuring efforts in Western Europe and will be all the more difficult given the depth of the recession and the inability of Greece to devalue.

Some analysts wonder if the ever-sliding euro could give Greece and Europe the devaluation and the competitive boost it so desperately needs — or whether it will again be too little, too late.

Greece is not the only country that must survive brutal spending cuts and maintain a fixed currency regime. The economies of both Latvia, as part of an I.M.F. program, and Lithuania, on its own, have shrunk by more than 10 percent as a result of deep pullbacks in government spending.

Mr. Lachman says that when the I.M.F. came to the rescue of Latvia, which also has a fixed currency, his staff recommended that the Latvian lat be allowed to float to ease the pain of the budget cuts.

“I know that the staffers were very unhappy with the program — they believed it would be impossible to achieve an adjustment in Latvia without moving the exchange rate,” Mr. Lachman said. “But the European Commission felt that if Latvia moved its rate, there would be contagion in Europe — so they put the pressure on.”

So far, neither Latvia nor Lithuania has been overwhelmed with the type of protests now occurring regularly in Athens.

But for Greece, where unions are powerful and already gearing up to oppose the government, not having the luxury to devalue the currency will make it all the harder for the fund’s program to succeed.